Big Al Repeats: Raise Rates

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Big Al Repeats: Raise Rates

NEWTON, Massachusetts – Federal Reserve chairman Alan Greenspan emphasized Monday that the U.S. central bank had no choice but to raise short-term interest rates in the months ahead to prevent the economy from overheating.

In a speech to company executives, market regulators, and academics, the world's most powerful central banker hammered home his message that productivity driven gains in the stock market had helped to boost demand in the economy to a level where it could no longer be met by supply. That risked stoking inflation and could kill off the record expansion prematurely.

"Until market forces, assisted by a vigilant Federal Reserve, effect the necessary alignment of the growth of aggregate demand with the growth of potential aggregate supply, the full benefits of innovative productivity acceleration are at risk of being undermined by financial and economic instability," he said.

Addressing a conference at Boston College, Greenspan said the increases in productivity not only had boosted corporate earnings but also company stock prices, which in turn bolstered the purchasing power of households who owned these assets.

This argument was first laid out in detail by Greenspan during his Humphrey-Hawkins testimony last month, in which he signaled the Fed may raise borrowing costs several times over the coming months to curb any resurgence in inflation.

His speech had little effect on financial markets, with many traders saying it told them once again what they already knew: the Fed is set to raise the key fed funds overnight bank lending rate by a quarter-percentage point to 6.0 percent at its March 21 monetary policy meeting.

Greenspan, who celebrated his 74th birthday on Monday, has defended his theory that productivity gains have kept inflation in check, but also have a darker side – boosting stock prices and thus actually contributing to inflation – as many on Wall Street are fretting they are now the target of his wrath.

Greenspan's high-caliber audience here gave him a polite welcome, and even joined into a rousing "Happy Birthday" before he started speaking, even though some of the Internet companies represented on the floor and their high-flying stocks appeared to be just those he was targeting with his remarks.

"Implicit in the very forces of change that bring us a panoply of goods and services considered unimaginable only a generation ago are potential financial imbalances," he said.

The Dow Jones industrial average of leading stocks trudged lower after his speech. But technology investors continued to thumb their nose at the Fed's message, and drove up the technology-heavy Nasdaq index by more than half a percentage point in early afternoon trading.

Greenspan's insistence on the need for higher interest rates has also been getting mixed reviews on Capitol Hill, where some lawmakers have raised concern about the impact of rising borrowing costs on their constituents. But Rep. Edward Markey, a Massachusetts Democrat who hosted Monday's conference, said he was sure Greenspan knew what he was doing.

"He is trying to the best of his ability to fine tune, through prudent decisions, the rate at which this boom continues," he told Reuters. "His agenda is to continue it."

Looking at how long the economy could cope with the surge in demand, Greenspan used much the same language as last month's testimony in saying that the economy was running out of ways to cope with too much money chasing too few goods.

"These safety valves that have been supplying goods and services to meet the recent increments to purchasing power largely generated by capital gains cannot be expected to absorb indefinitely an excess of demand over supply," he said.

While acknowledging that the acceleration in productivity growth had helped to keep a lid on inflation so far, Greenspan also warned that the tight U.S. labor market may have "serious implications" for the economy by its potential to spark an upsurge in inflation.